By Dr Joseph S Maresca, BLOGCRITICS.ORG

Published 6:42 am, Wednesday, May 8, 2013

The Endowment Model of Investing by Martin L. Leibowitz, Anthony Bova and P. Brett Hammond is an important work in finance. The main theme of the book is that the U.S. equities of stocks or bonds represent the primary risk elements in most institutional portfolios.

The U.S. institutional funds share common characteristics. For instance, the total portfolio volatility may be with the equities in stocks or bonds. In addition, the total projected volatilities are about 10% under normal market conditions. Despite the uncertainties, diversification remains one of the most powerful tools to reduce risk and enhance returns in the arsenal of tools available to the investor.

The authors explain how college and university endowment funds have increased their investment allocations from 3% to over 25% or more in non-traditional assets like real estate, hedge funds, private equity, natural resources and venture capital. At the same time, asset allocations decreased in such areas as fixed income, cash or cash equivalents. And so, U.S. equities continue to be the dominant risk factor for most institutional portfolios as demonstrated by the 2008 market crash.

The book explains that volatility in the markets is not dispositive. The more worrisome prospect is market deterioration so severe that it undermines an institution's investment philosophy and forces a fundamental reconsideration of basic assumptions underlying the investment portfolios. Vulnerable assets include international equity investments and emerging market equity during short term periods of stress in the markets which may translate to downside risk.

The authors have utilized the term "dragon risk" to denote unchartered territories where dragons might dwell. Examples are the potential perils of new investment vehicles like exotic derivatives and the wider range of performance outcomes for less efficient assets which depend more on having a top manager for the investment.

The Endowment Model of Investing is an important book on investments which describes both traditional and non-traditional investments, as well as, the inherent downside risks. This is an investment resource for anyone owning or managing a portfolio of any size or complexity.